Disappointing Day For Canadian Investors: No Ban On Embedded Commissions

In what should have been a historic day for Canadian investors, the Canadian Securities Administrators (CSA) instead disappointed with watered down reforms that skirt around the edges of true investor reform.

What investor advocates wanted was a ban on embedded commissions charged from mutual fund sales, and for the industry to adopt a best interest standard of care for its clients.

What we got instead was a ban on the already declining deferred sales charge option on mutual funds, a ban on trailer fees charged by discount brokerages (which shouldn’t have been allowed in the first place), and a ‘beefed-up’ suitability standard and disclosure on conflicts of interest that will surely be ignored. Pathetic.

The long awaited decision came after, and I’m not making this up, five-and-a-half years of consultation on mutual fund fees. The CSA knew then there was a problem when it stated:

“We identified how embedded commissions give rise to conflicts of interest that misalign the interests of investment fund managers, dealers and representatives with those of the investors they serve.”

The regulator then gathered compelling evidence that this type of compensation model for financial advisors leads to inherent conflicts of interest which leads to poorer outcomes for investors.

So what happened? Why did the CSA deliver such weak investor reform when the evidence clearly supported a ban on embedded commissions, as was done in Australia and the U.K.?

Score one for the industry: No ban on embedded commissions

Enter the powerful investment industry and its lobbyists, which have $1.49 Trillion reasons to maintain the status quo. The industry argued that unintended consequences would arise from the banning of commissions, namely that it would create an “advice gap” for smaller investors who could not afford to pay directly and upfront for financial advice.

It’s a bogus argument, and one that was proven wrong after the U.K. conducted a post-implementation review that found “the ban had reduced product bias from advisor recommendations and led to better investor outcomes.”

Industry lobbyists said advisors would leave the industry because their business model could not be supported without ongoing commissions from trailer fees. To that I say, “good riddance.”

The proliferation of online investing platforms (robo-advisors) and improved DIY options for investors have already started to fill any perceived gap. And are we really to believe that small investors are getting actual financial planning advice from their advisor? No, an annual phone call to make their RRSP contribution doesn’t cut it.

Finally, the industry wants to raise the professional standards for its advisors to their highest possible level through ongoing proficiency standards, continuing education requirements, and adhering to a code of professional conduct.

That’s commendable, but if the industry wants to be put on the same playing field as other professionals such as lawyers and accountants, then surely it wouldn’t object to a similar compensation model that would have advisors charge clients directly for advice. Right?

A letdown for Canadian investors

The CSA’s decision today is a huge letdown for Canadian investors. Advocates expected real reform, and instead the regulators caved-in to industry pressure and delivered half-measures at best.

Here’s what we get:

Enhanced conflict of interest rules for dealers and representatives requiring that all existing and reasonably foreseeable conflicts of interest, including conflicts arising from the payment of embedded commissions, either be addressed in the best interests of clients or avoided. (More regulations around the Know Your Client and Know Your Product forms)

Prohibit all forms of the deferred sales charge option and their associated upfront commissions in respect of the purchase of securities of a prospectus qualified mutual fund. (They’re banning DSCs)

Prohibit the payment of trailing commissions to, and the solicitation and acceptance of trailing commissions by, dealers who do not make a suitability determination in connection with the distribution of prospectus qualified mutual fund securities. (They’re banning trailing commissions on mutual funds sold through discount brokers, since these brokerages cannot give advice)

Why it doesn’t go far enough?

The deferred sales charge option is already disappearing from the industry (13 percent of total fund assets last year). Even Investors Group discontinued the DSC purchase option for its mutual funds on January 1, 2017.

Trailer fees should have never been applied to mutual funds sold through discount brokerages and, while this looks like a small win for investors, a proposed class action lawsuit filed against TD in April might have squashed this practice anyway.

The conflict of interest disclosure and amendments to Know Your Client and Know Your Product sound great on the surface, but without a fiduciary duty to look out for clients’ best interests these reforms lack any teeth and will continue to be ignored in practice.

All in all, it’s a sad, disappointing day for Canadian investors and investor advocates who were hoping to finally shake-up an industry that’s become all too powerful and complacent. Maybe in another five-and-a-half years?

Does the ban on DSC’s apply to existing funds that had DSC’s when they were originally purchased? I am hoping that they are banning all DSC’s past and present. It would allow me immediately to be free of IG

Hi Dave, my understanding is the practice of selling mutual funds with the DSC option will be discontinued but it is not clear if this ban will apply to existing fee schedules. I wouldn’t hold my breath.

I’d like to play devils advocate here for a bit, so I apologize in advance.

Why should I care if these changes are made or not? I have done my due diligence and have learned that ETFs/low fees are the best way for my family to invest. Why should I feel sorry for those suckers out there who don’t come to the same conclusion and fall for all scams (high MERs, DSCs, etc) out there being offered by the banks? Why should my tax dollars go to organizations that would protect those who are too lazy to look after their own finances.

When I started to first invest I fell for the banks sales pitches but I got smart about them pretty quick. And it wasn’t because some government entity took care of me, it was because I realized I should probably learn a little bit about the people/companies I’m trusting my family’s retirement with. And when I did that little bit of learning I realized there are better options out there. And those options are seriously not that complicated.

I’m always amazed at how little people know about investing and what their investments costs. And these are extremely successful people that you would think would have this part of their life sorted out. But I guess not.

So I come back to the question, why should I care if someone who is intelligent/fortunate enough to invest in their retirement piss away their monies on poor investments because they are too lazy to actually do an ounce of homework?

I guess I’m just tried of seeing my hard earned dollars (tax dollars) being wasted on those who are lazy and think everything should be handed to them.

And yes, I’m ready for any backlash. I just wanted to here some counter arguements

Hi Rob, it’s a fair question and you certainly don’t have to care about this issue. I’m of the belief that eliminating this type of compensation will lead to lower costs for investors across the board, which does impact you and me. I also dislike a business model in which charlatans are allowed to thrive.

You might see it as people being too lazy to do their homework, but there’s a fine line between ‘buyer beware’ and exploiting people’s lack of knowledge.

I’ll give you 74 reasons. Where I work the pension plan was administrated by an accounting manager who had no issues with dog like performance funds with IMF’s of 2 to 2.8% and NO advice other than directing you to – “on line investment tools”. I fought for years to at least get competitive reviews with other providers yearly and had multiple interactions with our account (salesperson) manager regarding their fees and some of their policies. Our administrator was totally oblivious to what was going on. The Broker of record totally snow jobbed her from day one.
To make a long story short, I am now part of a small pension committee we have, we eventually threw out the old broker, and now have a great fund lineup. (for example Mawer funds, + some index choices, asset allocation funds and others in all a much better lineup with something for every level of member knowledge) Our highest IMF is now 0.7%.

So now we have 74 people saving almost 2% in fees per year. This is the kind of industry BS that has to stop. It’s not being lazy, not everyone can take the time to fully understand how the system is stacked against them. As a member of a group pension plan, you don’t even have a choice. Even accountants with lots of letters after their names, and auditors I have had “convos” with,don’t fully get it (or even take an hour to learn).
Up until recently I would say 1/10 people would get it. Lately with the commercials from Portfolio IQ , bloggers, and John Oliver’s personal experience trying to get his staff a pension plan, maybe 2/10 get it in 2018? People want to live their lives and simply but sadly trust the banks smooth marketing schemes. The people helping you at the bank, have no idea about portfolio construction, and they give you “Advice”. Sorry that’s laughable if it wasn’t so sad at the same time.

Why am I not surprised about this?? How disappointing. The government should step in and force the industry to be completely transparent!! I like Rob & others who have commented did my own homework & have read blog upon blog, every article I can get my hands on, Moneysense magazine, books, Couch Potato blogs, and all the comments people make on them..and I have learned, & it added to my skepticism of the industry as a whole. It opened my eyes & has been quite an education..it is sad that this can continue to go on..I had decided (once I came to know how screwed I was getting by the banks) to move all my investments to a broker (Questrade) & invest in ETF’s myself, I only wish I had done it 10-15 years sooner than 2013..but once you know better you do better! You don’t know what you don’t know. I hope it was not too late to make a big difference to my portfolio as I am
already 58. I tell everyone I know to educate themselves & take control of their own investments. I went to a phenomenal Money Coach last year just to confirm that I am on the right track (who I selected from all the reading & research I have done) and he re-iterated everything I thought I knew & it’s the reason why he is in business doing what he’s doing. To help people keep more of their hard earned money!!
I can’t stress enough to others to leave the banks & get into simplified ETF’s, easy to rebalance & understand & ultimately more money in your own pocket. I know many advisors in the financial industry who have done phenomenally well, $, and I see why, their boat gets bigger and their clients may never get to own one. If I was in the industry (& I have thought about it) my goal would be that of a Money Coach, someone who actually has your financial best interests at heart.

Hi Barbara, thanks for your comment. It seems many of us followed the same path; invested in expensive mutual funds that provided little return, got no advice from our assigned ‘advisor’, and then eventually saw the light and went the DIY route. I’m happy today that there are resources out there to help people learn for themselves and maybe avoid some of the early mistakes we all made. And if they’re intimidated about DIY investing, there’s always the robo-advisor / fee-for-service planner combo. Young people will be in good hands.

My biggest worry is for seniors and immigrants who I think get taken advantage of more than we realize. Often times they truly don’t know any better, and so they buy everything their trusted advisor sells them. True investor reform and protection would make such a positive difference for these two demographics.